Shadow REO Inventory Is A Tricky Problem

Are you familiar with the term "Shadow REO" inventory? If not, don't feel bad because it doesn't get talked about a whole lot and unless you are in real estate then you probably haven't heard the term before. Shadow REOs are repossessed homes across the country that banks or investors have intentionally kept off the market, and it is estimated that up to 90% of repossessed homes are withheld from the market. As of April of this year CoreLogic estimates about 1.5 million foreclosed residential homes were just sitting in limbo. Shadow inventory is typically not included in the official calculations of unsold home inventory, meaning that whenever you read "official" statistics of home inventory you can add an additional 1.5 million homes to that figure because these homes are not being included, hence the term "Shadow Inventory."

The idea is that by refraining from dumping a large inventory of foreclosures on the market helps to keep home prices from crashing...in fact, a very good argument can be made that for this reason alone home prices have remained stable. Foreclosed properties are an extreme liability to the lender because when a lender carries an REO on its books, it is allowed to value the home at the price that the foreclosed-on borrower originally paid for it. Once the lender sells the home, it must realize a loss...which is the difference between the original purchase price and its current value. And since home values have fallen by nearly a third since the housing bust, that translates into huge losses for the bank. What's worse is that REO properties usually sell at about 33% less than their non-REO counterparts.

Releasing a flood of REO's on the market would be an absolute disaster however, because it would cause the bottom to fall out on the housing market and no doubt plunge the US into another deep recession. That doomsday scenario is what keeps the support going for lenders to continue holding onto their REOs.

At the same time however, keeping the supply of REOs off the market could prolong the housing slump since the market must take those properties at some point anyway. The proper handling of these REOs is a complicated, and sometimes obscure issue, with far reaching effects on the US economy and this will no doubt continue to cause uncertainty in the market.